Experimentation with pricing structures will let the broadband providers -- and their customers -- test new business models without regulatory interference

By Daniel A. Lyons

Computerworld|Jun 18, 2013 9:17 AM
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Internet providers have invested several hundred billion dollars in the past decade to build America's broadband networks, and analysts expect them to spend an additional $30 billion each year to keep up with growing bandwidth demand. This growth has left providers wrestling with how to price Internet access in order to fairly distribute those costs among their customers.

Some providers have adopted speed-based service plans, in which a customer can purchase faster service at a higher price, while others are exploring usage-based plans, which offer consumers a fixed amount of data each month for a fee. Both of these strategies are forms of what economists call price discrimination: a strategy to charge more to those who are willing to pay more for a service. These pricing trends are evolving, a process that should be encouraged. The Federal Communications Commission should resist pressure to regulate Internet pricing more directly by favoring one pricing model over another. Providers -- and their customers -- are fully capable of feeling out which plan best serves them.

In truth, both approaches have strengths and weaknesses. But it is unclear that speed-based pricing is superior for most consumers, or that the FCC should discourage usage-based pricing as an alternative (as Weinberg suggests). Each is simply a strategy for dividing broadband customers into different segments. Speed-based pricing does so by creating tiers with varying quality of service, whereas usage-based pricing offers tiers with varying quantity of service. This subtle distinction impacts consumers in important ways.

For example, speed-based tiering can help identify those customers who use more advanced Internet applications. Services such as online gaming and videoconferencing often perform less than optimally at low speeds. If a provider uses speed tiers in its pricing, it can charge higher prices to consumers who use such advanced services, and less to consumers like the grandmother who only wants to check her email and browse the Web. But speed tiers leave less room to sample more advanced services before paying. For example, if Grandma wishes to try to video chat with her grandchildren, the connection is likely to be pretty choppy unless she first upgrades to a higher-speed tier.

By comparison, usage-based pricing distinguishes between lighter and heavier data consumers. Grandma can try video chatting without changing her data plan, and she'll have the same quality of connection as any other customer of her provider. Eventually, she may reach her data limit earlier in the month, whereupon her provider will likely warn her as she approaches that limit, and she can decide whether to spring for a higher tier. But usage-based pricing lumps together all who upload or download large quantities of data. This is imperfect if the provider seeks to distinguish, for example, heavy online gamers and Apple TV users from less sophisticated consumers who happen to use a nightly cloud-based data backup service.

It is unclear which system is more intuitive to consumers. The average customer is unlikely to know if his household needs require a download speed of, say, 50Mbps, or whether 20Mbps is sufficient. Nor will he know whether a 200GB or 300GB cap is better for his needs. The edge may go to usage-based pricing just because many household basics, such as water and electricity, are priced that way. One need not know how many kilowatt-hours the air conditioner uses to realize that blasting the AC leads to higher electricity bills, and conservation can bring bills down. Similarly, customers should generally be aware that streaming video is more data-intensive than Web surfing, so households engaged in significant streaming should purchase a higher-tier plan. But under both regimes, consumers learn which tier is appropriate by testing different plans and adjusting them as their online habits change.

Fortunately, both regimes have signals to inform consumers when they should upgrade services. As Weinberg notes, customers on low-speed tiers will notice service delays if they adopt advanced services or connect multiple devices. Those are prompts telling them to purchase a higher-speed plan. Similarly, usage-based pricing customers can use real-time data meters to monitor monthly data consumption, and as mentioned above, most providers send texts or emails when customers approach their plan limits.

Of course, both regimes are susceptible to anti-competitive abuse. Both slow speeds and low monthly data limits can deter customers from using Internet-based video providers like Netflix. But I have argued elsewhere that these anti-competitive concerns are likely overstated. Customers unsatisfied with one company's pricing model will switch to an alternative provider. And anytime that is not possible because a company has market power that inhibits competition, antitrust law should come into play and protect broadband consumers, just as it does consumers in every other sector of the American economy.

Experimenting with business models can lead to innovation and more efficient competition. This virtuous circle is especially prominent in dynamic markets like broadband. Commentators often stress the importance of protecting online innovation, forgetting that pricing innovation can be as revolutionary as technological innovation. For example, pricing innovations helped shape the dial-up Internet market. In 1996, when most providers were charging an hourly rate, America Online attracted significant market share by introducing an unlimited, flat-rate model. NetZero responded with a free, advertising-supported model that was popular for some time but ultimately fizzled. It was the experimentation that let companies determine which model best suited dial-up consumers.

More of us are online today than in 1996, and the online experience varies dramatically by individual consumers. Price discrimination allows companies and users to respond to this change. A company with a popular pricing structure will attract customers. Unpopular or unprofitable pricing models will wither on the vine as NetZero did. The right pricing plan may vary by consumer, and by provider. Regulators should resist pressure to disrupt this virtuous cycle by trying to pick winners and losers. Rather, they should intervene only to remedy antitrust violations. Consumers benefit from companies' experiments to find new and more efficient pricing structures to govern an increasingly diverse marketplace.

Daniel Lyons is an assistant professor of law at Boston College Law School.